Consumption in the Great Recession: The Financial Distress Channel

Athreya, Kartik B.; Mather, Ryan; Mustre-del-Rio, Jose; Sanchez, Juan M.

Working Paper

Consumption in the Great Recession: The Financial Distress Channel

Abstract: During the Great Recession, the collapse of consumption across the US varied greatly but systematically with house-price declines. Our message is that household financial health matters for understanding this relationship. Two facts are essential for our finding: (1) the decline in house prices led to an increase in household financial distress (FD) prior to the decline in income during the recession, and (2) at the zip-code level, the prevalence of FD prior to the recession was positively correlated with house-price declines at the onset of the recession. We measure the power of the financial distress channel using a rich-estimated-dynamic model of FD. We find that these channels amplify the aggregate drop in consumption by 7% and 45%, respectively.

Keywords: Consumption; Credit Card; Mortgage; Bankruptcy; Fore- closure; Delinquency; Financial Distress; Great Recession;

JEL Classification: D31; D58; E21; E44; G11; G12; G21;